Why Some Countries — But Not the U.S. — Are Stopping Stimulus

Why Some Countries — But Not the U.S. — Are Stopping Stimulus

They first did it on Oct. 6, they did it a second time on Nov. 3 — and,
oops, Australia may raise interest rates again in December this year or in
February next year. “A further gradual lessening of monetary stimulus is
likely to be required over time if the economy evolves broadly as expected,”
the Reserve Bank of Australia said last week. It expects GDP to expand 1.75%
this year, more than three times its forecast in August.

Australia is so way Down Under that what happens there often seems far
removed from the rest of the world. Not this time. The Aussies’ aggressive
tightening is seen as the start of the global exit from the unprecedented
liquidity governments have injected into their financial systems to avert an
economic depression.

It’s a potentially dangerous step. No one knows exactly how a withdrawal
will affect the tentative global economic recovery — just as it is not
clear, even now, whether interest rate cuts and huge stimulus spending in
the U.S. and elsewhere are resulting in sustainable economic growth. The
world is in uncharted territory. Policymakers are acting on the fly, without
much in the way of historical precedence to guide them.

Investors, including those saving for retirement, are on uncertain ground as
well. The global crisis and the stimulatory monetary and fiscal policies
that were brought to bear against it have overturned all the verities about
long-term investing. Exiting from those policies is not likely to reinstate
them. How will equities, bonds, commodities, oil, gold, currencies and other
investment vehicles fare in the post-crisis, post-stimulus-spending world

For Australia’s central bank, inflation and asset bubbles in an environment
of easy money evidently now trump worries of a second-dip recession. Its
October and November decisions, which raised interest rates from 3% to 3.5%,
are meant to keep inflation between 2% to 3% in 2010. The country’s consumer
price index as of September actually rose just 1.3%, but the fear is that
the resurgent economy and government’s $38 billion in cash handouts and
infrastructure spending will push inflation above 3%.

Other central banks are making similar calculations, although they are not
moving as aggressively — yet. The Bank of Japan will terminate its
purchases of corporate debt this December. The Bank of England is cutting
back on a program to buy government bonds and commercial paper with newly
created money. The European Central Bank is mulling an end to its 12-month
loans to banks next year. “Not all our liquidity measures will be needed to
the same extent as in the past,” says ECB president Jean-Claude Trichet.

The G-20, the group of developed and developing economies that has taken
over the G-8 industrialized countries as the decision-maker in global
economic affairs, agreed over the weekend to adopt a detailed timetable in
order to coordinate the world’s stimulus exit. The first steps are slated to
be announced by the end of January next year. “If we put on the brakes too
quickly we will weaken the economy and the financial system,” warned U.S.
Treasury Secretary Tim Geithner, “and the ultimate cost of the crisis will
be greater.”

The U.S. Federal Reserve is also talking the talk, although it is difficult
to see how it can actually walk the walk. After a year of contraction, U.S.
GDP grew 3.5% in the third quarter of this year, but the jobless rate has
surged to 10.2%, the highest since 1983. Raising interest rates runs the
risk of worsening unemployment. For the same reason, the U.S. cannot
withdraw stimulus spending either, even though the U.S. budget deficit has
topped a record $1.7 trillion. Last week, mortgage lender Fannie Mae
reported $18.9 billion in third-quarter losses and said it needs another $15
billion in taxpayer money to survive.

Indeed, U.S. President Barack Obama wants to spend even more. “My economic
team,” he said last week, “is looking at ideas such as additional
investments in our aging roads and bridges, incentives to encourage families
and businesses to make buildings more energy efficient, additional tax cuts
for businesses to create jobs, additional steps to increase the flow of
credit to small businesses, and an aggressive agenda to promote exports and
help American manufacturers sell their products around the world.”

The potential increases in U.S. stimulus spending even as other economies
start to withdraw their programs and tighten monetary policy bring more
uncertainty to the prospects for the global economy. One early casualty is
the U.S. dollar, which has weakened significantly against most other major
currencies. A continued fall appears likely as investors park their capital
in Australia and elsewhere, because interest rates are trending higher there
and economic growth is far more robust than in the U.S.

For now the weak dollar is helping America’s exports. But it is also
spooking holders of U.S. debt, whose continued purchases of U.S. Treasury
bills allow Washington to fund its deficit spending. Last week, the
International Monetary Fund announced that the Reserve Bank of India
had bought 200 tons of IMF gold reserves, the biggest single purchase by a
central bank in 30 years. That pushed the price of gold past $1,100 an
ounce, the latest record-breaker in a string of new highs, as the market
anticipated gold buying by other central banks to hedge against a falling

No one quite knows where the world will end up in this new roundelay of
policy decisions and feedback loops. What is clear is that there needs to be
some measure of coordination among central bankers and policy makers as they
exit stimulus measures and tighten monetary policy. It is fortunate that the
planet now has forums such as the G-20 and reinvigorated multilateral
institutions like the IMF to help in this regard.

But at the end of the day, governments will make decisions based on what
they believe is best for their economy and people. The winners will be those
who can draw the correct lessons from the still unfolding economic crisis
and can act on them speedily — yet also have the flexibility to change
tack as the decisions of other policy makers and other external events
change the economic picture. Brace yourselves for more uncertainty and

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